Preferential Trade Agreements, Trade Creation and Trade Diversion

Henri Joel Nkuepo

One of the fundamental principles of trade liberalisation is that of non-discrimination as enunciated in articles I of the GATT, II of the GATS, and IV of the TRIPS Agreement. This principle, Most-Favoured-Nation (MFN), means that WTO members are not allowed to discriminate between their trading partners. Thus, if a member grants a favour to one member, it has to grant the same favour to others. However, Paragraphs 4 to 10 of Article XXIV of GATT was introduced as an exception to this principle. It allows the establishment of arrangement between members through which one member can grant more favourable trade conditions to other parties of the arrangement and not to other WTO members. The Enabling Clause, aimed at increasing developing countries’ participation, was also introduced as an exception to the MFN in favour of developing countries. It allows the establishment of Preferential Trade Arrangements PTAs between these countries.

From this definition, it appears that the current formulation of PTAs provisions in the WTO system is not just an exception to a trade principle (to the MFN), but that it is more like contrary to the organisation’s fundamental principles and seems to make PTAs’ rules superior to those of the WTO. It is true; PTAs are a creation of the WTO, but the way they operate makes them comparable to the WTO, and even almost superior. PTAs today can be regarded as “multiplied WTOs” in different regions of the world. They sometimes take measures which are more restrictive than WTO rules. One of the most blatant examples is found in TRIPS-plus measures taken in some bilateral agreements between developed and developing countries. Developed countries negotiate deals with developing countries that establish much stronger requirements for Intellectual Property Rights (IPRs) than the WTO TRIPS Agreement. If these kinds of situations are not addressed by the WTO, the TRIPS agreement may soon be superseded. It is important to act on these issues as quickly as possible because the delay of the DOHA round of multilateral negotiations plays a role in the proliferation of PTAs.

It must be acknowledged that one of the reasons why article XXIV of the GATT was introduced, increasing trade liberalisation and trade flows between WTO members, is met today. Finding suggests that the world preferential deals have increased and that PTAs have created more trade than they have diverted. The proliferation of PTA today justifies this statement. In East Asia for example, it is argued that Free Trade Agreement FTAs have reinforced trade among firms despite the concern over restrictive rules of origin.

FTAs give birth to two important concepts: trade diversion and trade creation. Trade creation signifies that a free trade area creates trade that would not have otherwise existed. In the case of trade creation, supply occurs from a more efficient producer of the product as an increase in imports displaces less efficient domestic production. This is beneficial to the economy and has a positive impact on the population.

Trade diversion signifies that FTAs divert trade away from a more efficient supplier, non-member, towards a less efficient supplier within the FTA. Let’s consider an African country, Rwanda. Rwanda imports food stuffs, machinery and equipment, steel, petroleum products, cement and construction material and its main providers are Kenya and Uganda. However, its export partners are China and Belgium. I believe that Rwanda import mostly from Kenya and Uganda because they belong to East African Community EAC and not because they have comparative advantage. Furthermore, the principal export of Rwanda is coffee, tea and tin and these are also produced and exported by Kenya. Thus, instead of exchanging with countries which have absolute or comparative advantage, Rwanda is constrained to trade with counties which struggle to produce. This is not good for both countries and the question is, are developing countries ready to support the consequences of trade diversion? The rules of PTAs seem to be too severe strict for developing countries’ economy and should be revised accordingly. It seems that a developing country gains more when it enters into an agreement with a developed country. This is because trade plays an important role in fostering development and because increased trade with developing countries enhances their export earnings, promote their industrialisation and encourage the diversification of their economies. The WTO has put in place the “Special and Differential Treatment” to help developing countries and the EU has implemented the “Generalised System of Preferences” which is an arrangement that benefits least developed countries and territories while trading with the EU. An example is the “Everything But Arms” which grants duty-free access to imports of all products from LDCs, except arms and ammunitions, without any quantitative restrictions.

However, it must not be understood that trade among developing countries is not encouraged. My point is that these countries must put their development objectives above their regional commitments. Developing countries need machineries, Foreign Direct Investment (FDIs) for the exploitation and transformation of their natural resources. I do not see how another developing country will help in this case. Developing countries should negotiate trade agreements with developed countries which are able to invest in the exploitation and transformation in the developing country. The WTO can assist in putting in place an Agreement on the Trade in Natural resources which protects investors, human rights and the environment and to stop developing countries’ leaders from transforming the principle of permanent sovereignty over natural resources into the principle of personal sovereignty over natural resources. In doing this, the organisation could implement fair trade in natural resources that will mean that no natural resources should be bought from countries where leaders are corrupt. PTAs between developing and developed countries could help in implementing those measures.

REFERENCES

Grain (2001) TRIPS-plus through the back door: How bilateral treaties impose much stronger rules for IPRs on life than the WTO. Available here

DeRosa D.A. and Hufbauer G.C. (2007) What do gravity models tell us about PTAs impact on trade flows: More creation or more diversion? Available here

Kawai M. and Wignaraja G. (2010) Free Trade Agreements in East Asia: A Way Toward Trade Liberalisation? Available here

Suranovic S.M. International Trade Theory and Policy, online book available here

Henri Joel NKUEPO is a Ph.D. student in International Trade Law (University of the Western Cape - Cape Town) and a Research Intern at the South African Human Rights Commission. His research focuses mainly on the regulation of the trade in natural resources, protection of Human Rights, Environment and protection of Foreign Direct Investments in natural resources.